Our guest blog post comes from Dennis Purvine of CFO Selections. Dennis is a CPA and CFO and has worked with companies in all stages of development.
Intellectual Property (I.P.) can be protected by patent, copyright, trademark, etc. Companies that create, or purchase, intellectual property presumably create value for their business. (More on this “value” later.) As such, the costs incurred in acquiring the I.P., whether done in-house or purchased from an outsider, should be capitalized and shown on the balance sheet. Showing the intellectual property on the balance sheet reminds everyone, including bankers, shareholders, and eventually the potential purchasers of the business, that the company has intellectual property which may increase the company’s value.
The actual value of the I.P. is determined by the competitive advantage that the I.P. gives the company. For example, the company has a patent that allows them to make an item that is superior to the competitor’s items. This may result in a higher unit price for the item and/or an increased number of units sold – simply because they are better. Or the company may have a process that allows them to make an item, of the same quality, for a lower cost than their competitors. Again, this places the company at a competitive advantage.
This competitive advantage can be measured in terms of greater sales and/or profit compared to their competitors. When a company is being valued, either as a potential purchase or for succession planning, the value that the I.P. adds is taken into account. One client of mine produced a copyrighted product that was of much higher quality than the competition. As a result, his company produced and sold more than 90% of these items that were sold in the United States. (Please do not tell the Federal Trade Commission!) When the company was sold, the copyright increased the price of the sale. I have also seen companies purchased mostly to gain access to their intellectual property.